It’s been a day of competing economic prescriptions from two doctors: Vince Cable  (‘debt’s so cheap it’d be rude not to borrow more!’) and today Liam Fox, who has delivered a speech to the Institute of Economic Affairs. Here are Dr Fox’s main points.

His main proposal is a freeze on state spending, so it would not rise with inflation (right now, it’s rising by just under 1pc less than inflation each year). This would set Britain on a far faster path of fiscal consolidation: the high road, if you like, versus the current low road where there is no longer a published plan to balance the books.

It’d mean the government spending about £90bn less. You can see the Labour war room calculating — as it did with Oliver Letwin in 2001 — £90bn of cuts! Armageddon! Fox confronts this head-on. The choice is not between government spending or hunger and destitution, he says. It’s a question of who spends money: government, or the people? Debt is nothing but deferred tax. In a way, debt is a worse tax because it allows one generation to have another pick up its bills.

Lower state spending means lower tax – this, he says, means not only a wealthier but a more socially-cohesive society. So yes, it’d be £90bn less state spending. But..

 ‘as a Conservative, such a commitment doesn’t scare me.  I believe that the country will be at its best when the Government is small and people are left to enjoy the fruits of their own labour.  I believe that in leaving money in people’s pockets, economic activity will follow.  People will buy houses, invest for their future or just go shopping.

Fox’s only point of overlap with Cable is questioning the ring- fencing of departmental. Here are his other points:

  • Scrap tax on savings interest
  • Limiting access to housing benefit for Under 25s
  • Emergency cut, or even suspension, of in capital gains tax. ‘This would create a tax window where businesses that are sitting on assets might be encouraged to sell, investment in capital becomes more attractive and where hundreds of thousands of second homes might come on to the market.’ The Sunday Telegraph also advocated this at the weekend
  • Restrict further ‘deeply immoral’ taxes on income that has already been taxed at source
  • Challenge the language of economic debate: challenge the idea of tax cuts as cash handouts ‘when they are really just letting you keep your own money’

Now, is Fox’s idea too extreme? You might have argued two years ago that if the government sought real-terms savings of just 1pc a year then the budget would be balanced within five years. This was the Treasury’s plan, reflected in the green dotted line below. But it wasn’t enough. The other colours show how the debt picture worsened with every subsequent revision and now (dark blue) Britain’s debt/GDP ratio is expected to keep on rising:

DEBT/GDP PROJECTIONS – HOW THE PICTURE HAS CHANGED. (Source: Citi)

Now, the above graph explains why Britain has lost its AAA credit rating. The markets no longer believe that Britain has a credible debt reduction strategy.

George Osborne has taken this on the chin, and next week is likely to stick to his spending plan even if it means more debt. And the markets wear it, for now. Government borrowing costs actually fell the week after the downgrade and now the 10-year gilt yield is just 2.01pc.

This is what leads Dr Cable to say: look! The markets are asking us – begging us! – to borrow more. It’s a freak economic occurrence, so let’s use this cheap debt to build schools etc. He’s right that it’s a freak condition, for reasons that Allister Heath set out in his seminal article on the ‘bond bubble’ in Sep11.

But if the bond bubble bursts, and if sentiment changes, then any Chancellor — of any party — would be forced to find more savings in state spending. And the end result may look a lot like the spending plan which Dr Fox prescribed today.

Tags: Budget 2013, IEA, Liam Fox, Plan A